State audit of Montebello

8/3/2019 State audit of Montebello

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CITY OF MONTEBELLO

Review Report

STATE AND FEDERAL EXPENDITURES

July 1, 2009, through June 30, 2010

JOHN CHIANGCalifornia State Controller

November 2011



November 1, 2011

Art BarajasMajor of the City of Montebello1600 West Beverly BoulevardMontebello, CA 90640

Dear Mayor Barajas:

The State Controller’s Office performed a review of the City of Montebello’s:

State and federal funding for the period of July 1, 2009, through June 30, 2010

Selected transactions relating to the Transit Operations Fund for Fiscal Year (FY) 2008-09

Financial Transactions report relating to state and federal funds for FY 2009-10

The city reported $23,065,067 in state and federal expenditures (excluding gas tax funds) inFY 2009-10; we questioned $1,983,191, or 8.6% of the total reported expenditures.Additionally, we reviewed selected transactions of the Transit Department for FY 2008-09 andquestioned $1,984,170. Specifically, our review identified the following issues:

The city charged the Transit Department with unsupported administrative expenditures from

July 1, 2008, through June 30, 2010, totaling $3,967,361 ($1,983,191 in FY 2009-10 and$1,984,170 in FY 2008-09). This practice, which affects all funds and agencies that arecharged for administrative costs, has been in place since 1992. In addition, the Transit Fundincurred expenditures that should have been paid from the General Fund.

Cash in the Transit Fund and other restricted funds may have been impaired because of thecity’s use of such funds to pay for expenditures that should be paid from the General Fund.

The current and prior contracts and the award and oversight of engineering services for capitalimprovement projects do not comply with the city’s own ordinance requiring competitive

bidding and creates the appearance of conflict of interest and lack of independence. It also

does not assure that the city receives the best competitive price for its engineering services forcapital improvement projects.

The report includes a detailed explanation of all findings and recommendations. In addition,it includes, as an attachment, the response from the city — signed by Mr. Larry Kosmont, theInterim City Administrator —to a draft of this report. We have responded to the city’s input in

the report. Generally, our findings and recommendations remain unchanged. It should benoted that the city’s r esponse generally indicates agreement with the findings, if not therecommendations.



Art Barajas -2- November 1, 2011

In the city’s response, Mr. Kosmont argued that the SCO issued its final report on Montebello’s

redevelopment agency earlier this month without considering the city’s comments. In reality,each of the responses provided by the interim city manager was closely reviewed by staff fromthe Controller’s auditing, accounting, and/or legal units. If there had been previously

undisclosed information or a legal argument that proved compelling, we would not havehesitated to revise or correct our findings. The SCO is steadfast in conducting and issuing auditreports in compliance with government auditing standards issued by the Comptroller General of the United States governing independence, objectivity, and due professional care. However,Mr. Kosmont’s responses were largely flawed, non-salient, or — in some cases — only served toreinforce our conclusions.

Mr. Kosmont also called the SCO’s report ―highly detrimental‖ to the city’s effort to secure

outside financing. This is a specious statement. If investors do, indeed, walk away from thecity’s debt offering, it will not be the result of the disclosure efforts made by this office or any of

the law enforcement, regulatory, or news agencies that are currently investigating Montebello’s

handling of public funds. Rather, it will be because of what has been disclosed. Regrettably,both recently completed audits have exposed extensive fiscal mismanagement and substandardfiduciary oversight that, in part, explains Montebello’s current state of fiscal distress.

This office cannot whitewash, diminish, or delay the release of these findings simply becausethey are inconvenient truths. Not only do taxpayers have a right to know how their money isbeing spent, but — by law — potential investors are to be provided with all material facts anddisclosures that can aid them in making an informed decision about the city’s ability to service

the proposed loan in a timely manner.

Our office hopes that the City of Montebello will embrace the findings and recommendationsfound in this series of audits. Many months and audit hours were invested in pursuit of diagnosing the causes of the city’s current problems and, more impor tantly, offering a roadmapto recovery.

As always, my staff and I are available to address your questions or aid in your efforts to restorethe city’s fiscal health. Please contact Steven Mar, Chief, Local Government Audits Bureau, at

(916) 324-7226.

Sincerely,

Original signed by

JEFFREY V. BROWNFIELDChief, Division of Audits

JVB/wm

cc: Larry Kosmont, Interim City AdministratorCity of Montebello

Keith Breskin, Interim Assistant City AdministratorCity of Montebello

Francesca Schuyler, Director of FinanceCity of Montebello



City of Montebello State and Federal Expenditures

Contents

Review Report

Introduction ....................................................................................................................... 1

Background ........................................................................................................................ 2

Objective, Scope, and Methodology ................................................................................. 3

Conclusion .......................................................................................................................... 4

Views of Responsible Officials.......................................................................................... 4

Restricted Use .................................................................................................................... 5

Schedule 1 — Schedule of State and Federal Expenditures ................................................ 6

Findings and Recommendations ........................................................................................... 7

Attachment —City’s Response to Draft Report




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Review Report

The State Controller’s Office (SCO) performed a review of the City of Montebello’s:

State and federal funding for the period of July 1, 2009, through

June 30, 2010

Selected transactions relating to the Transit Operations Fund forFiscal Year (FY) 2008-09

City Annual Report of Financial Transactions (Financial TransactionsReport) report relating to state and federal funds for FY 2009-10

This report presents the results of findings and conclusions reached in theSCO review of the city’s expenditures of state and federal funds(excluding Fund 04 – Gas Tax Fund) and the Financial TransactionsReport with respect to state and federal funds.

On April 21, 2011, the SCO notified Interim City Administrator PeterCosentini that the City of Montebello had not complied with state lawregarding the submittal of required annual reports and independentaudits, as follows:

The Financial Transactions Report of Cities for FY 2009-10, which isrequired by Government Code section 53891 and due to the SCOwithin 110 days after fiscal year-end, was not filed until June 16,2011, approximately seven months late.

The Single Audit Report, which is required of any city having more

than $500,000 in federal expenditures and was due to the SCO onMarch 31, 2011, was not filed until April 7, 2011.

The city has been delinquent in providing these reports in past years.These delays in compliance have raised concerns about the reliability andaccuracy of the information in the reports. This was of particular concernin light other information about the city’s financial practices, including:

The 2008-09 single audit of the City of Montebello identified severalmaterial or significant deficiencies in the city’s internal controls over financial reporting and compliance. Several of the deficiencies hadbeen noted in previous audits and still had not been resolved.

Recent presentations to the Montebello City Council contained thefollowing information:

Restricted funds under the control of the city have been used to pay for the city’s general purpose administrative costs.

Reimbursement of the restricted fund loans have been madepossible only by loans of $14.8 million from funds that aresupposed to be used for redevelopment programs.

Introduction




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The use of restricted funds and redevelopment loans are the onlyreason the city has avoided deficit spending in its general fund.

Without actions to reduce expenditures or increase revenue, thecity was projected to run out of cash by October 2011. Amongother things, this would have meant that city would not meetfinancial obligations, including paying employees.

The city recently was made aware that two ―off -the- books‖ bank accounts had been in existence for more than ten years without theknowledge of the city. It is not clear whether these accounts werereflected in the prior Annual Report of Financial Transactions forCities submitted by the city.

The Interim City Administrator resigned effective May 13, 2011,because the Montebello City Council would not consider timelyaction to address the financial issues raised by the Interim CityAdministrator.

After considering the above information, the SCO concluded that therewas reason to believe that the FY 2009-10 Financial Transactions Reportsubmitted by the city was false, incomplete, or incorrect. Therefore,under Government Code section 12464, subsection (a), our officeconducted an investigation to gather the information needed to validatethe information provided by that report.

In addition, the SCO reviewed programs receiving State general orspecial funding and/or any federal funding passed through the State tothe city. These additional activities were conducted under GovernmentCode section 12468 which authorizes the State Controller to―. . . regularly audit the apportionment and allocation by counties of

property tax revenue . . . ,‖ and under Government Code section 12410which authorizes the Controller to ―. . . superintend the fiscal concerns of the state. The Controller shall audit all claims against the state, and mayaudit the disbursement of any state money, for correctness, legality, andfor sufficient provisions of law for payment.‖

The focus of our review was on FY 2009-10; however, issues came toour attention that necessitated reviewing financial transactions in FY2008-09.

The City of Montebello is located in Los Angeles County, California.

The population was 64,695 as of 2007, living in an area of 8.2 squaremiles. On October 16, 1920, Montebello was incorporated as the 35th of the present cities in Los Angeles County. The city conducts its operationsas a general law, Council/Administrator City.

Background




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The objective of this review was to evaluate the expenditures of the Cityof Montebello’s state and federal funding for compliance by:

Reviewing the city’s accounting system to verify whether it hassufficient controls to accumulate, account for, and segregate costs.

Reviewing the city’s accounting records and supporting

documentation to determine if costs claimed are reasonable,allowable, and allocable, and are adequately supported.

Determining if payments by the city are legal and proper.

Reviewing bidding process/procedures to verify compliance withstate, federal, and/or city procedures.

Verifying that the city complied with contract provisions.

Verify the accuracy of the Annual Report of Financial Transactions.

To accomplish our review objective, we performed the followingprocedures:

Evaluated the city’s formal written internal policies and proceduresnecessary to perform the stated objective.

Conducted interviews with city employees and observed the city’sbusiness operations for the purpose of evaluating administrative andinternal accounting controls necessary to accomplish the statedobjective.

Reviewed the city’s documentation and supporting financial records.

Performed tests of selected transactions on a risk-based approach toensure adherence with prescribed policies and procedures and tovalidate and test the effectiveness of controls.

We also reviewed and inquired about other audits/reviews of state andfederally funded programs. These audits/reviews disclosed significantfindings and an allegation of possible criminal activity as noted:

U.S Department of Housing and Urban Development — Audit of Affordable Housing and Community Development Block Grant Funds

We did not review the U.S Department of Housing and UrbanDevelopment’s (HUD) affordable housing and community developmentblock grants because it is our understanding that HUD has audited theprogram and is performing an investigation into possible occurrences of criminal activities related to these funds.

Objective, Scope,

and Methodology




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In an audit report issued by the U.S Department of Housing andUrban Development’s Los Angeles Office of Community Planningand Development on July 8, 2010, HUD required the city to repay$1.3 million in HOME project funds, plus interest, and place the fundsinto the HOME U.S. Treasury account. They found that the city’sWhittier and 6th Street project was not timely, and the city committedand disbursed $1.3 million in HOME funds without the required written

agreement, and that the city also recorded the project as completed in theIntegrated Disbursement and Information System (IDIS) although noproject construction had begun.

HUD previously sent a letter to the city dated June 16, 2011 that included32 findings and two areas of concern. First, this letter disclosed thatHUD was questioning an additional $3.1 million in HOME fundsexpended by the city. HUD also notified the city that the city’s access toaffordable housing and community development block grant funds wasrestricted, specifically in the HOME program, because of multipleviolations disclosed in previous audits and reviews.

Our review disclosed that the City of Montebello accounted for andexpended state and federal awards described in Schedule 1 of this reportin compliance with state and federal program guidelines for the periodJuly 1, 2009, through June 30, 2010, except as noted in Schedule 1 anddescribed in the Findings and Recommendations section of this report.

Our review disclosed that the City of Montebello charged Transit Fundwith unallowable expenditures that resulted in incorrect revenues andexpenditures reported in the FY 2008-09 and FY 2009-10 FinancialTransaction Reports. Also, Transit Fund and other restricted funds mayhave been impaired to address General Fund expenditures. In addition,

the current and prior contracts and the award and oversight of engineering services for capital improvement projects do not complywith the city’s own Ordinance 2304, and creates the appearance of conflict of interest and lack of independence and does not ensure that thecity is getting the most competitive price for its capital improvementprojects.

The specific findings and recommendations in this report should be takeninto consideration when preparing the city’s Financial TransactionsReport for FY 2010-11.

We issued a draft report on October 10, 2011. Larry Kosmont, InterimCity Administrator, responded by letter dated October 20, 2011,disagreeing with the audit results. The city’s response is included in thisfinal report as an attachment.

Conclusion

Views of Responsible

Official




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This report is solely for the information and use of the City of Montebello and the SCO; it is not intended to be and should not be usedby anyone other than these specified parties. This restriction is notintended to limit distribution of the final report which will be a matter of public record.

Original signed by

JEFFREY V. BROWNFIELDChief, Division of Audits

November 1, 2011

Restricted Use




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Schedule 1 —

Schedule of State and Federal Expenditures

July 1, 2009, through June 30, 2010

ReportedExpenditures

TestedExpenditures

AmountQuestioned Reference1

STATE AWARDS

Peace Officer Standards and Training (POST)

Fiscal Year (FY) 2009-10 $ 53,053 $ 53,053 $ —

Transportation – StateProp 1B – Public Transportation Modernization,

Improvement, and Service Enhancement (PTMISA) 1,460,437 1,460,437 —

Transportation Development ActArticle 4 – Capital Outlay 238,629 238,629 — Article 4 – Transit Operation (FY 2009-10) 5,270,811 5,270,811 1,983,191 Finding 1State Transit Assistance Fund 872,187 872,187 —

7,895,117 7,895,117 1,983,191

FEDERAL AWARDS

Fines and Forfeitures 89,183 89,183 —

TransportationARRA – Energy Efficiency and ConservationBlock Grant 534,108 534,108 —

Federal Grant (Section 3) 273,698 273,698 — Federal Grant (Section 9) 13,195,980 13,195,980 — Congestion Mitigation & Air Quality 1,076,981 1,076,981 —

Total Expenditure of Federal Awards 15,169,950 15,169,950 —

Total Expenditure of State and Federal Awards $ 23,065,067 $ 23,065,067 $ 1,983,191

__________________________

1 See Findings and Recommendations section.




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Findings and Recommendations

Noncompliance With Government Code Section 12464

We reviewed the City of Montebello’s Annual Report of Financial

Transactions (Financial Transaction Report) for Fiscal Year (FY)2009-10 and FY 2008-09 relating to reported state and federal funds.

With respect to Government Code sections 12463.3 and 12464, ourreview determined that the state and federal funding transactions for FY2009-10 reported by the city were incomplete and/or incorrect asfollows:

FINDING 1 — The city overstated reported expenditures in the TransitFund (Fund No. 614) by $1,983,191 in FY 2009-10 and $1,984,170 inFY 2008-09, by billing the Transit Fund for unsupportedadministrative costs.

FINDING 2 — The city overstated reported expenditures in the TransitFund (Fund No. 614) by charging unallowable costs associated withcharter services (Employee Appreciation Day).

FINDING 3 — Cash in the Transit Fund and other restricted fundsmay have been impaired.

FINDING 4 — The current contract for engineering services and theaward and oversight of capital improvement projects does notcomply with the city’s own Ordinance 2304 requiring competitivebidding and creates the appearance of conflict of interest and lack of

independence. It also does not assure that the city receives the bestcompetitive price for its capital improvement projects.

The above findings should be taken into consideration when preparingthe city’s Financial Transactions Report for FY 2010-11.




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For FY 2008-09 and FY 2009-10, the city charged administrative costs tothe Transit Fund (Fund No. 614) in the amounts of $1,984,170 and$1,983,191, respectively. Each transaction was made through a single journal entry that transferred funds from the Transit Fund to the GeneralFund without any supporting documentation as to what these chargeswere for and how they were determined. When questioned, the cityaccounting staff responsible for making the journal entries could not

provide any explanation as to the methodology for calculating thecharges. We were also told that no further documentation was availablerelated to those journal entries during the period of the audit.

However, in response to a State Controller’s audit report issued in

September 2011, on a similar issue regarding the city’s RedevelopmentAgency, the city asserted that its ― . . . level of administrative charges toits various funds, including Redevelopment is supported and well withinan acceptable range based on any number of recovery methods. While noevidence was provided for this conclusion, the city also admitted that itscurrent allocation program has not been updated since 1992 and notedthat it was engaged in an effort to update the plan for allocation of

administrative support costs for all funds and agencies for use in2011-12.

Even if the 1992 cost plan had been properly prepared, it would notconstitute sufficient and competent evidence for the period of the audit

because the city’s administrative structure and expenditure patternundoubtedly changed significantly in the more than 18 years since it wasprepared. Our office has issued a handbook to assist local governments(counties) in developing cost allocation plans in accordance with BudgetRules and Regulations; Title 2, Code of Federal Regulations, Part 225,Appendix C (also referred to as OMB Circular A-87). The regulationsand handbook establish principles and standards to provide a uniform

approach for determining costs and to promote effective programdelivery, efficiency, and better relationships between governmental unitsand the federal government. Sections D3 and D4 of the regulations state:

3. All other local governments claiming central service costs mustdevelop a plan in accordance with the requirements described in thisCircular and maintain the plan and related supporting documentationfor audit. These local governments are not required to submit theirplans for Federal approval unless they are specifically requested to doso by the cognizant agency. Where a local government only receivesfunds as a sub recipient, the primary recipient will be responsible fornegotiating indirect cost rates and/or monitoring the sub recipient'splan.

4. All central service cost allocation plans will be prepared and, whenrequired, submitted within six months prior to the beginning of each of the governmental unit's fiscal years in which it proposes to claimcentral service costs. Extensions may be granted by the cognizantagency on a case by case basis. [emphasis added ]

FINDING 1 —

Unsupported

administrative costs

were charged to the

Transit Fund.




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Recommendation

The city’s General Fund should reimburse the Transit Fund for$1,983,191 in unsupported administrative costs charged in FY 2009-10and $1,984,170 for unsupported administrative costs charged in FY2008-09. Additionally, the city should review prior period charges to theTransit Fund and reimburse the fund for unsupported administrative

charges.

The city should ensure that its efforts to develop and implement anequitable method to distribute administrative costs to the Transit Fund aswell as all benefiting departments is in accordance with the OMBregulation cited above.

City’s R esponse

As noted in the City's response to the State Controller's Office ("SCO")audit regarding the Montebello Redevelopment Agency (issued inSeptember 2011), the City acknowledges that its current cost allocationstudy, last updated in 1992, is outdated. In an effort to respond directlyto the SCO's concerns stated in the prior audit, the City provided ananalysis based on an adjusted cost allocation model, whichdemonstrated that the administrative costs allocated to theRedevelopment Agency were supportable notwithstanding the lack of aregularly updated cost allocation model. Despite the City's efforts, theSCO rejected entirely the City's response.

The City began the process of updating its cost allocation model in2010 by retaining the firm of Willdan Financial Services ("Willdan") toundertake this effort. Willdan, a recognized leader in this area,completed a Cost Allocation Plan for the City in October 2010, and theCity intended to review and implement the model for its administrationallocations for Fiscal Year 2011/12. However, due to the City's

burgeoning financial crisis, coupled with staff turnover, the prior Citymanagement team made a decision to delay the allocation effort. Thenew management team does not agree with that determination and hasrestarted and accelerated the completion of the updated model.Accordingly, the City's new management team intends to review andmake adjustments as may be necessary to the pending cost allocationmethodology by Willdan, and is on track to have an updated model inplace for Fiscal Year 2012/13. An updated cost allocation model willaddress all of the SCO's concerns regarding unsupported administrativecosts.

The SCO should suspend this finding, pending the completion of theWilldan cost allocation model and the application of its conclusions by

the City.




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SCO’s Response

The city’s request that the SCO suspend this finding is denied,particularly because, in its response, the city, in essence, acknowledgesand supports the SCO finding that it had no basis or support for itsadministrative charges to the Transit Fund and has initiated actions toaddress the finding through its work with the Willdan Cost Allocation

Plan.

If the Wildan Cost Allocation Plan is properly prepared and updated ontime, it should provide sufficient basis for future allocations and supportadministrative costs to the Transit Fund and other funds and agencies,such as the Redevelopment Agency mentioned in the city’s response.

However, the city should be aware that this plan may not provideadequate support for the administrative cost allocations for the prioryears as numerous factors, such as expenditure fluctuations amongdifferent departments and programs, could render the cost allocation planinapplicable for those years. We continue to recommend that the city

review past periods for unallowable levels of charges.




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In June 2009, the city held an Employee Appreciation Day at DodgerStadium. The city used its transit buses for the event (charter services)and did not reimburse the Transit Fund for costs associated with the useof these buses. Non-transit uses such as charter services are not eligiblecosts and must be reimbursed.

Public Utilities Code section 99247 states:

For purposes of Section 99246, and as used elsewhere in this article:

(a) ―Operating cost‖ means all costs in the operating expense objectclasses exclusive of the costs in the depreciation and amortizationexpense object class of the uniform system of accounts and recordsadopted by the Controller pursuant to Section 99243, and exclusive of all subsidies for commuter rail services operated under the jurisdictionof the Interstate Commerce Commission and of all direct costs forproviding charter services, and exclusive of all vehicle lease costs.

Recommendation

The city should calculate all costs associated with the use of transit busesfor Employee Appreciation Day and reimburse the Transit Fund for thosecosts. The city should develop, implement, and monitor policies andprocedures regarding the use of transit buses to avoid ineligible chargesin the future.

City’s R esponse

The City has calculated all costs associated with the use of the transitbuses for Employee Appreciation Day, and has fully reimbursed theTransit Fund for such costs. On October 5, 2011, the City reimbursedthe Transit Fund $1,704.60 for the use of 3 buses for the Dodger GameTrip on June 4, 2009. A copy of the Request to Issue a Warrant, and thewarrant check No. 532710, is attached as Exhibit A for furtherreference. These funds will be used towards the purchase of a federally-funded capital project. City staff will also undertake the formation of policies and procedures for the future use of transit buses.

The SCO should acknowledge that the City fully reimbursed theTransit Fund prior to the SCO's issuance of its draft report, andeliminate this finding.

SCO’s Response

The city’s response validated that this finding was correct and it will

remain. The SCO acknowledges that the city has reimbursed the TransitFund. However, reimbursement was made more than two years after theunallowable charge was made and then only because the matter wasbrought to the city’s attention by the SCO during its review.

FINDING 2 —

Ineligible costs were

incurred by the Transit

Fund.




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The General Fund is the main operating fund for the city and its cash ismaintained in an investment pool with cash from other funds, includingrestricted funds (such as the Transit Fund). During our review, we notedthat the city operating costs of the General Fund was paid for by fundsfrom the city’s investment pool, which includes the Transit Fund andother restricted funds.

The General Fund cash balances were negative the entire 2009-10 fiscalyear with the exception of June 2010 (see Column A in the table below).At year end, the city made journal entries and transferred cash betweenGeneral Fund and other funds to eliminate the negative cash balance forfinancial statement purposes. The city employed this practice in pastyears. The General Fund continued to have negative cash balances, forall months in FY 2010-11 and has continued into FY 2011-12. When theGeneral Fund cash balances are negative, it means that the cash fromother funds in the investment pool, including restricted funds such ascash in the Transit Fund, is being used to pay for General Fund-relatedexpenditures. Thus, any of these other funds that have a positive cashbalance are potentially impaired and may not be able to make timely

payments of required expenditures that should be made from those funds.

Most of the administrators of these other funds do not know how theirfunds are being affected because the City of Montebello’s financedepartment does not provide timely financial information to them.However, staff of the city’s transit department does prepare its own cashflow analysis. (The Transit Fund cash flow analysis for FY 2009-10 isshown in Column B in the table below.) The calculated cash balances, asreported for transit purposes, shows the Montebello Transit Fund havingpositive cash balances for ten months in FY 2009-10. The two months of cash deficits (February 2010 and April 2010) were attributed to the delayby Montebello Transit to draw down discretionary funds because timely

financial information was not available from city’s finance department. If timely information was available, the Transit Fund would have received1/12 of $5,042,576 (TDA discretionary funds), or $420,215 per month.This would have eliminated any cash deficiencies for both February andApril 2010.

Column A Column B Column C

Fund 1

General FundFund 6141

Transit FundTransit Fund

Cash Impaired

July 2009 $ (2,298,725) $ 6,423,876 YesAugust 2009 (3,896,375) 4,995,632 YesSeptember 2009 (8,031,223) 2,817,122 YesOctober 2009 (11,545,496) 4,044,436 YesNovember 2009 (13,549,969) 4,447,632 YesDecember 2009 (13,520,144) 3,865,733 YesJanuary 2010 (11,085,658) 2,500,231 YesFebruary 2010 (11,846,667) (219,843) NoMarch 2010 (14,791,374) 3,530,720 YesApril 2010 (16,286,313) (453,997) NoMay 2010 (14,665,733) 1,253,864 YesJune 2010 99,414 7,111,892 Yes_____________________________1 The amounts reported under Fund No. 614 consist of revenues and expenses, a

$2 million loan from the Redevelopment Agency (July 2009) and cash balances of theProp A Local Return Fund, Prop C Local Return Fund, and the Measure R Fund.

FINDING 3 —

Cash in the Transit

Fund and other

restricted funds may

have been impaired.




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It is clear that General Fund expenditures were charged to other funds inthe investment pool which included the Transit Fund and other restrictedand non-restricted funds. However, we could not determine the specificimpact to the Transit Fund or any other funds because the city’sinvestment pool does not provide information on the balances on eachfund or document specific loans to the General Fund from these otherfunds. As a result, restricted funds may be used for unallowable

expenditures or may be impaired.

Recommendation

The city should develop and implement policies and procedures to ensurethat it does not impair other funds’ cash, especially the restricted funds,by using them to pay for general operating costs that should be paid fromthe General Fund. Additionally, the finance department should determineeach fund’s balance in the investment pool and ensure that withdrawalsfrom that pool are only used to address costs that can be paid from eachfund. In addition, to the extent that it is allowable to use cash from onefund to pay for expenditures that should be paid from another, such loans

should be documented and ensure that the loan is repaid as soon asrequired, with interest.

Also, the city should establish and maintain a separate bank account forthe Transit Fund. This account should only be used to record TransitFund transactions and ensure that such transactions are made in a timelymanner.

City’s Response

Past practices by the City, as noted in prior years' ComprehensiveAnnual Financial Reports (CAFRs), was to maintain minimum fundbalances within the City's General Fund and maintain multiple funds of cash which can be pooled as part of the General Fund. A schedule of funds which are pooled as part of the City's operating cash is attachedas Exhibit B. The cash reflected in these funds are considered as"Alternative Liquidity" and can be applied and negated against anycash balances in the General Fund. This alternative liquidity practice issupported by a legal opinion from the City Attorney as well as theCity's Bond Counsel. (Please see Table 8 of the City's FinancialDisclosure as it relates to TRAN Borrowing, attached as Exhibit C).

By including these other fund balances, cash in the Transit Fund, aswell as the Gas Tax Fund, could not have been impaired as the GeneralFund can include these other Funds' cash balances in its overall cashposition. It is unclear as to whether SCO staff included the City's

alternative liquidity in determining a cash position that would cause theTransit Fund and/or Gas Tax Fund to be impaired. As indicated in theschedule provided in Exhibit B, the City's Self Insurance Fund providesthe most amount of cash for the City's alternative liquidity position.Although the City is not aware of any statutory requirement for theCity to maintain a minimum cash balance to offset its claims payable,the City maintains sufficient reserves to cover the present value of expected losses and a reasonable margin for contingencies. The SCOrecommends that the City establish a separate bank account for theTransit Fund; the City's position, however, is that a separate account is




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not necessary and will result in a doubling of transactions for which theCity and State will have to account, leading to increased possibleproblems in the future.

Ongoing solution: Recent actions taken by the City Council include abalanced budget for Fiscal Year 2011/12, approval of financialprinciples, approval of a General Fund Financial Recovery Plan,approval of a 2011/12 Tax Revenue Anticipation Note / Short Term

Borrowing, have addressed all underlying issues which were present inthe prior fiscal year. The City will ensure monthly transfer of TransitFund-eligible expenditures to the Transit Fund reflect actual activity.Transfers to the General Fund from other funds for overhead costs willbe reviewed annually and will conform to the Office of Managementand Budget A-97 Guidelines. The City will correct these past practices,and is in the process of identifying and implementing new procedures.

The SCO should eliminate this finding.

SCO’s Response

While the finding will not be eliminated, the SCO has made someadjustments to clarify our finding that the city is unable to documentwhich fund, restricted or not, has been used to pay for General Fundexpenditures. Therefore, the city cannot provide any assurance thatrestricted funds were not used to pay for General Fund expenditures.

Also, while we agree and acknowledged in the finding that the city canmake temporary loans from non-restricted funds, such as the Self-Insurance Fund (the source of funding of which appears to be GeneralFunds), to address General Fund expenditures, there is nodocumentation that only these funds were used for this purpose.

Therefore, the SCO continues to recommend that the city establishprocedures to document inter-fund loans, pay them back on time andwith interest when applicable, and ensure that restricted funds are notused for this purpose.

Finally, it should be noted that the actions the city listed under―Ongoing solutions‖ do not appear to address the SCO finding, exceptfor the city’s assurance that it will make timely transactions involvingthe Transit Fund.




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Advanced Applied Engineering (AAE) has been the city’s contractedcity engineer for more than ten years. Under its contract with the city,AAE also is allowed to perform capital improvement project services forthe city. Under the contract, AAE is to submit a Request for Service(RFS) to the City Administrator for approval prior to the start of anycapital improvement project. However, during the audit year, all RFSrequests have only been for awards made to AAE. An AAE employee

asserted that the engineering retainer of $500,000 per year is not veryprofitable and that capital improvement projects are where the firmmakes its profits.

The city paid AAE a total of $2,544,503 in FY 2009-10, of whichapproximately $500,000 was for services as the city engineer. The other$2 million was paid for engineering services for capital improvementprojects. During this period there were no awards for capital improvementprojects to any firm other than AAE for engineering services. Under thecontract, AAE is responsible for providing oversight of all capitalimprovement projects awarded to itself including approval of invoicesand assurance of compliance with the project requirements.

The city provided a copy of a contract with AAE awarded in 2002 and asecond one that was awarded in 2005. The 2005 contract contains a

provision stating that the contract will be ―automatically renewed‖ inone-year increments for succeeding years, unless either party terminatesthe contract. The contact has been extended each year and is currentlystill in place.

In 2008, the City Council passed City Ordinance 2315 which contains aprovision (3.21.060) that specifies contracts in excess of $50,000 are tobe competitively bid.

Based on the above information, we identified the following concernswith respect to the city contract with AAE:

The automatic extension provision in the 2005 contract with AAE hasno end date which means that the competitive bid requirement can becircumvented indefinitely for this contract.

The provision that allows AAE to utilize the Request for Service(RFS) process for capital improvement projects to the extent that theyexceed $50,000 also circumvented the city’s competitive bidrequirement as many of such projects were more than $50,000. Thecity engineer is responsible for, among other duties, ensuring thatwork on all capital improvement projects conform to plans andspecifications or the city standards. However, under the currentcontract, AAE is in the position of performing oversight on projectsawarded to itself. As noted above, more that $2 million was paid toAAE for such projects during the audit period. Under thisarrangement AAE has a potential conflict of interest because itsindependence is compromised.

FINDING 4 —

The city has failed to

comply with its own procurement ordinances

which raise concerns

about possible conflict of

interest and lack of independence in its award

and oversight of capital improvement projects. In

addition, it does not

assure that the city will receive the best

competitive price for its

capital improvement

projects.




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Recommendation

The city should comply with its own ordinance by taking the followingactions:

Set an end date for the current engineering contract and develop andimplement a competitive bid process to award a new contract.

Require that all future engineering services for capital improvementprojects over $50,000 be competitively bid.

When engineering services for capital improvement projects areawarded to AAE, or any subsequent contractor, establish anindependent review of the work performed and payment of invoices.

Besides complying with its own ordinances, the city will remove anyappearance of conflict of interest or lack of independence in its awardand oversight of capital improvement projects and its engineeringprogram. In addition, it will ensure that the city is getting the mostcompetitive price for such services.

City’s Response

The SCO is correct that the City awarded a contract to AdvancedApplied Engineering, Inc. ("AAE") in January 2005, and that pursuantto the terms, the agreement is automatically renewed for additional one-year periods unless the City terminates the agreement.

The SCO is mistaken, however, by applying a City ordinance that didnot exist at the time the contract was awarded. Chapter 3.21 ("Contractsfor Professional and Special Services") of the Montebello MunicipalCode ("MMC") was adopted in June 2007 by Ordinance No. 2304 --two years after the City Council awarded the contract to AAE inJanuary 2005. The Chapter was later amended in 2008 by OrdinanceNo. 2315. Thus, at the time the City Council approved the agreementwith AAE in January 2005, Chapter 3.21 in its present form did notexist.

Under California law, "[Laws] enacted subsequent to the execution of an agreement ... are not ordinarily deemed to become part of theagreement unless [the agreement's] language clearly indicates this tohave been the intention of the parties." Torrance v. Worker's Comp.

Appeals Bd. (1982) 32 Cal.3d 371, 378. In the present matter, althoughthe agreement between the City and AAE is subject to state law[Article 15, subd. (b)], the agreement is not expressly subject to prospective laws.

Indeed, changes in substantive law generally have no impact onexisting contracts. Expansion Pointe Properties Ltd. Partnership v.

Procopio, Cory, Hargreaves & Savitch, LLP (2007) 152 Cal.AppAth42, 56. "[S]tatutes, ordinances or by-laws operate in the future only,

and are never given a retroactive effect if susceptible of any otherconstruction." London v. Robinson et al. (1928) 94 Cal.App. 774, 776(emphasis added). When adopted in 2007 and amended in 2008, MMCChapter 3.21 did not expressly apply retroactively, and there is noevidence of any intention by the City Council that the ordinance was toapply to any existing agreements. Thus, the SCO is incorrect underCalifornia law to demand the City apply an ordinance adopted in 2007and amended in 2008 to an agreement approved in 2005.




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In fact, if the City were to adopt the SCO's position, the City may beexposed to potential litigation. As noted above, Chapter 3.21 does notexpressly apply retroactively. If the City took the position that Chapter3.21 does apply retroactively (without any express intent in theordinance itself), it is possible the City may be subject to a claim that itbreached the agreement, or that the law itself impaired the obligationsof a contract. See, e.g., Assn of Blue Collar Workers v. Wills (1986) 187Cal.App.3d 780, 793-94 (relating to employee pension funds).

In sum, the SCO's position is in conflict with general legal principles,and ipso facto, as applied to specific circumstances the City could beexposed to litigation if it were to adopt the SCO's position.Notwithstanding the foregoing, the City is committed to receiving thebest competitive prices for its capital improvement projects, isevaluating the current agreement with AAE, and will consider goingout to bid for its engineering services in the future.

Based on the above, the SCO should eliminate this finding.

SCO’s Response

The city appears to have misunderstood the finding and recommendation.We recognized that the agreement, signed in 2005, was before Ordinance2304 was enacted in 2007, and acknowledged that in this finding. Inaddition, we did not recommend that the city apply the new ordinanceretroactive to the selection of AAE for the current contract. The issue weraised was that the contract allows for indefinite annual extensions.

Extensions allowed after Ordinance 2304 was enacted appear to violatethe intent of the City Council when it took action to adopt it. We haverecommended that, rather than extending the contract at the end of thecurrent year, the city comply with its own ordinance by re-bidding it toensure best value and proper accountability in the use of public funds.

The city appears to acknowledge the appropriateness of therecommendation as it indicates in its response that it will consider this inthe future.

Finally, we note that the city has not addressed the finding andrecommendation regarding the Request for Services process wherebyAAE can award engineering services for capital improvement projects toitself. Awarding contracts in this manner creates a potential conflict of interest and lacks accountability and transparency. It also appears thatany such contracts awarded after Ordinance 2304 was enacted shouldcomply with the provisions of that ordinance.




Attachment —

City’s Response to Draft Report



State Controller’s Office

Division of Audits

Post Office Box 942850

Sacramento, CA 94250-5874

http://www.sco.ca.gov

S12-SPA-902

State audit of Montebello

Documents

Transcript of State audit of Montebello